Quanex Building Products - Earnings Call - Q1 2019

Transcript

Speaker 0

Good day, ladies and gentlemen, and welcome to the First Quarter twenty nineteen Quanex Building Products Corporation Earnings Conference Call. At this time, all participants are in a listen only mode. Later, we will conduct a question and answer session and instructions will be given at that time. As a reminder, this call is being recorded. I'd now like to introduce your host for today's conference, Mr.

Scott Zilke, Vice President, Investor Relations and Treasurer. Please go ahead.

Speaker 1

Thanks for joining the call this morning. On the call with me today is Bill Griffiths, our Chairman, President and CEO Brent Corb, our CFO and George Wilson, our COO. This conference call will contain forward looking statements and some discussion of non GAAP measures. Forward looking statements and guidance discussed on this call and in our earnings release are based on current expectations. Actual results or events may differ materially from such statements and guidance, and Quanex undertakes no obligation to update or revise any forward looking statement to reflect new information or events.

For a more detailed description of our forward looking statement disclaimer and a reconciliation of non GAAP measures to the most directly comparable GAAP measures, please see our earnings release issued yesterday and posted to our website. I'll now turn the call over to Brent to discuss the financial results.

Speaker 2

Thank you, Scott. I'll start with a review of the income statement and finish with comments on cash flow and the balance sheet. After my prepared remarks, I will hand the call over to Bill, who will provide comments about our performance and expectations going forward. Before I begin, note that we have made a small name change to the two window and door related segments such that the term engineered components has been replaced by fenestration to more accurately reflect the primary end market. You will now see us using the names North American Fenestration and European Fenestration with no change to the North American Cabinet Components names.

We generated net sales of $196,800,000 during the 2019 compared to $191,700,000 for the first quarter of twenty eighteen. The increase was mainly due to the healthy revenue growth of more than 6% in our North American Fenestration segment that was driven by market growth combined with new business wins and some favorable pricing late in the quarter. We reported a net loss of $3,600,000 or $0.11 per diluted share for the three months ended January 3139 compared to net income of $4,900,000 or $0.14 per diluted share during the same period of 2018. The EPS driver in the first quarter of last year was a $6,500,000 or $0.19 per diluted share net tax benefit related to the Tax Cuts and Jobs Act that was enacted on December 2237. On an adjusted basis, we had a net loss of $2,300,000 or $07 per diluted share during the 2019 compared to a net loss of $1,500,000 or $04 per diluted share during the first quarter of twenty eighteen.

The adjustments being made for EPS are restructuring and related severance expense, transaction and advisory fees, foreign currency transaction impacts, along with the net tax benefit related to the Tax Cuts and Jobs Act. On an adjusted basis, EBITDA for the quarter was $12,100,000 a $1,000,000 reduction from $13,100,000 in the first quarter of last year. The decrease in adjusted earnings was primarily attributable to an increase in SG and A expense driven by elevated medical costs. Now let's move on to cash flow and the balance sheet. Cash used for operating activities was $20,200,000 for the three months ended January 3139 compared to cash provided by operating activities of $8,200,000 for the three months ended January 3138.

Cash receipts were unfavorably impacted by a reduction in net income as well as unfavorable working capital changes, including a higher payout of accrued incentives, higher spending on the seasonal inventory build and a reduction in cash collected from accounts receivables compared to 2018. Regarding the share repurchase program, we had approximately $26,000,000 remaining as of January 3139. This is after repurchasing 144,030 shares of common stock during the quarter for a total of approximately $2,000,000 at an average price of $13.98 per share. Largely as a result of borrowing to fund incentive payouts and share repurchases, our leverage ratio of net debt to adjusted EBITDA increased to 2.4 times as of January 3139. We are confident in our ability to generate strong free cash flow in the second half of the year and expect to pay down debt while opportunistically buying back stock.

We also expect to exit fiscal twenty nineteen with a net leverage ratio of between 1.5 to two times. I will now turn the call over to Bill. Thanks, Brent.

Speaker 3

When we issued guidance for fiscal twenty nineteen back in early December, there was some skepticism around our ability to achieve revenue growth of 4% to 6% in light of all the negative rhetoric around homebuilding and the building product sectors generally. As we complete the end of our first fiscal quarter, which is typically our most challenging due to seasonality and weather, we are reporting consolidated revenue growth of approximately 4% excluding the foreign exchange impact. This was driven by above market growth in our Fenestration businesses both in Europe and North America. In Europe, revenues grew at 10.5% excluding the foreign exchange impact and in North America, revenues grew 6.2%. In our European Fenestration segment, price increases implemented late last year accounted for about 50% of the revenue growth and helped boost margins by almost 300 basis points as prices finally caught up with inflationary costs.

Similarly, in our North American Fenestration segment, price increases accounted for a little over 25% of the revenue increase. But because those increases only went into effect in January, we did not see the full effect in the quarter and margins actually shrank by 80 basis points. Looking ahead, however, we expect to see the full benefit of price increases in Q2 and would expect slight margin expansion in this segment for the remainder of the year. Our North American Cabinet Components segment had a challenging quarter with revenues down almost 4% compared to the prior year. This was a result of a number of factors.

First and foremost, overall industry cabinet shipments, specifically in the semi custom segment, were down by about 5% year over year when compared to the first quarter of twenty eighteen. It's worth mentioning that cabinet shipments were strong in our fiscal fourth quarter last year, which may help explain why many customers shuttered production over the December holidays for extended periods. The number of unplanned down days was then exacerbated by plant closures in January due to extreme weather in the Upper Midwest. Those unplanned down days caused production inefficiencies and excessive overtime, which negatively impacted margins. Volume started to recover in February, however, and we expect this positive trend to continue through the year.

Overall, despite the softness in our North American Cabinet Components segment in Q1, we are confident in reaffirming our prior fiscal twenty nineteen guidance of 4% to 6% consolidated revenue growth, dollars 97,000,000 to $107,000,000 in adjusted EBITDA and $50,000,000 to $55,000,000 in free cash flow. As a reminder, we generate nearly all of our cash in the second half of our fiscal year. In addition, as Brent said, even though we were a net borrower in Q1, which increased our leverage ratio to 2.4, we fully expect to close the year with a leverage ratio between 1.52 times, while still opportunistically buying back stock over the balance of the year. You heard Brent talk about renaming our Fenestration segments. In conjunction with this and in an effort to be more efficient as an organization, we consolidated leadership, sales, finance, IT and accounting in North America from three business units into one.

This is a forward looking approach designed to streamline our organization so that we can better meet the needs of our customers, employees and shareholders. These moves resulted in severance and restructuring costs of approximately 1,250,000 in the first quarter. The consolidation took place at the January, but was incorporated into our 2019 operating plan and therefore into our guidance for this year. On an annualized basis, the cost savings are expected to be between 2,500,000.0 and $3,000,000 approximately $2,000,000 of which should be realized this year and was built into our guidance for fiscal twenty nineteen. This consolidation will also facilitate our ongoing commitment to reduce and maintain lower working capital levels as we progress through the year.

And on a separate note, I would like to take the opportunity publicly to thank Leroy Nossbaum for his valued contributions to our Board as an Independent Director since 2010. Under our corporate governance guidelines, Mr. Nossbaum will not stand for reelection at our Annual Meeting of Stockholders on March 22. Don Meyer, who is currently the CEO of Armstrong Flooring, is standing for election in Leroy's place. As a matter of good governance, we will continue to refresh the composition of our Board as appropriate.

And now operator, we're ready for questions.

Speaker 0

Thank Our first question is from Daniel Moore with CJS Securities. Your line is open.

Speaker 4

Good morning, Bill. Good morning, Brent.

Speaker 3

Good morning. Good morning, Dan.

Speaker 4

You started to and gave pretty good color, Bill, but maybe just elaborate a little bit on those the customer the North American cabinets, some of the customers that took a little bit more extended downtime around the holidays, are those back up to running at full schedule? You alluded to February volumes starting to come back. Maybe any more color there would be great.

Speaker 3

Yes. As we sort of closed out the calendar year, a number of customers actually took extra days out of production over the holidays. And then January with the extreme weather in the Upper Midwest caused some plant closures, but mostly a lot of absenteeism, a lot of trucking companies came off the road for a number of days because of the weather conditions. And as a result of that, ended up having to work excessive overtime and obviously very inefficient for production through month of January, hence the margin shrinkage. Volumes have started to bounce back pretty nicely in the month of February and are up year over year even though it's still early yet.

Speaker 4

Got it. And then maybe a step back, North American Fenestration, after a couple of years of some pretty good competitive pressures, it seems like things have stabilized. Do you see are you seeing an opportunity to win back some of the business that maybe you walked away from previously given your price discipline?

Speaker 3

Yes. So in the first quarter, we started production with some new business in our vinyl extrusion business. That contract was signed late last year, but as you know, it's a long lead time to get into production. We have a second piece of new business where the contract is being signed. We'll start production in our second quarter and but it won't fully ramp up until the second half of the year.

And then also in Q1, we actually started some new screen business as well. So yes, we are winning back some business, which is encouraging. And the reason for the consolidation is I think we're at a stage in our life cycle now with the three primary Fenestration businesses that linking them together on the one set of leadership, one set of back office and one sales force now makes sense. And we'll continue to see efficiencies improve as we go through the year.

Speaker 4

Helpful. And lastly for me, on the EU side of house, maybe just talk about cross currents, Brexit concerns, what you're seeing there and outlook for growth both in terms of underlying and on an FX adjusted basis for the remainder of the year?

Speaker 3

Yes. Realistically, I don't think that growth rate is sustainable. We clearly did see some customers build in inventory. And I'm sure, as you've read in the popular press, everybody seems to be doing that from whether it's stockpiling food at home or product in the event of some form of border closure. I think at this point, nobody really knows what's going to happen.

Our belief is that growth rates will slow down to a more normalized low single digit number as we go through the year. I think a lot of the great growth was attributable to Brexit stockpiling. We also stockpiled some inventory as well for the same reasons, but still feel very good about the jurisdiction and still feel confident that this will get resolved in a manner that won't be overly disruptive to trade.

Speaker 4

Got it. Thank you. I'll jump back if I have any follow ups.

Speaker 0

Thank you. Our next question is from Steven Ramsey with Thompson Research Group. Your line is open.

Speaker 5

Good morning. I guess starting with the business that you have won back, you know, I guess kind of is there a way to ballpark the percentage that you won back from what was lost? And is there any way to kind of have a read on in the next, you know, even into fiscal twenty twenty, if there's opportunity to win more back?

Speaker 3

So we lost, my recollection is $70,000,000 $75,000,000 in total between a number of the businesses. We do not expect to get all of that back in what we've been awarded so far. And not all of this is coming from customers where we lost business. Some of this are existing customers where we're getting new contracts or new customers. So it's not all a return of business we lost.

But it is on an annualized basis less than $20,000,000 across the business.

Speaker 0

Helpful.

Speaker 5

Thank you.

Speaker 3

Our expectation is though, we will continue to win new business based on the quotation pipeline we have. And as I mentioned earlier, a lot of this is long cycle business that from negotiation and contract signing to being in production can often be a couple of quarters.

Speaker 5

Right. Okay. Helpful. Thinking about the spacer business and the investments you've been making, I guess, you update us on if demand is still strong in that segment and where you are with investments and adding new lines to meet the demand?

Speaker 3

Yes. Demand is still strong. But as I've mentioned before, the inhibitor is really the ability of the equipment manufacturers to supply our customers with those lines and they're being added at the rate of about three a year across the customer base. Still strong interest and obviously still helps the spacer business, but not a step change in volumes.

Speaker 5

Great. And then lastly, on cabinets, just a lot of shifting parts in that business with imports and how the market is segmenting on the low end and the high end. Can you maybe also talk to consolidation in the space or recent acquisition or proposed acquisition activity kind of along with the tariffs kind of how those moving parts impact the cabinet business going forward?

Speaker 3

I think the real answer is it's still too soon to tell. There was clearly an announcement from one of our larger customers this week about a strategic review of their businesses. There is no certainty that, that will be consummated in a transaction and no certainty that, that will result in any consolidation. And as we've seen in the window space through some recent acquisitions, most of the acquisitions are to access new markets or new territories and typically don't result in a consolidation of production. And so thus far, our expectation is and with conversations with customers that are directly involved in this, the word thus far is business as usual.

We don't expect to see any change. All of the players that are moving parts are current customers. And at this point, we would expect that to continue.

Speaker 5

Excellent. Thank you.

Speaker 0

Thank you. Our next question is from Ken Zener with KeyBanc. Your line is open.

Speaker 6

Hi. This is actually Brian on for Ken. So as cabinets improve, should we be expecting a similar margin profile relative to 2018? Just trying to figure out the cadence of margin expansion there as we go forward relative to 2018.

Speaker 3

Yes. We certainly expect to see significant margin expansion simply by virtue of volumes. It is back end loaded. But we fully expect the year to finish at better overall margins than last year.

Speaker 6

Great. Thank you. And then given Europe Engineered Components did very well with, I. E. EBIT margin going up almost 400 bps year over year, how should we be thinking about the cadence for margins for the remainder of the year given you had guided to 2019 margins being flat to slightly down year over year?

Thank you.

Speaker 3

Yes. I think for North American fenestration, we will see slight margin expansion. We did guide to flat. We may see slight margin expansion as we progress through the year based on what we can see right now.

Speaker 6

I was talking about Europe Engineered Components, not North America.

Speaker 3

Sorry, European?

Speaker 6

Yes, yes, yes. European, please.

Speaker 3

Yes. That margin profile clearly was assisted by the increase in volumes. I think if our thinking is correct, the volumes will start to or growth rates will subside somewhat in the second half of the year. I wouldn't expect that level of margin expansion to continue, but I would expect to see some margin expansion as we go through the next three quarters.

Speaker 6

Okay. So for the year, you're saying margins could be flat to slightly up now instead of flat to slightly down? Yes. Okay, great. And then just my final question, 6% growth in North America Engineered Components was very good.

Can you just talk about how you would rank the growth between the businesses there between the warm edge spacer screens and extrusion and why, please? Thank you.

Speaker 3

We're seeing steady growth in the spacer business primarily as a result of the high speed line installations that we talked about earlier. We're seeing growth in screens as a result of new business and we're starting to see potentially the highest growth in our extrusion business as we get awarded new contracts there.

Speaker 6

Great. Thank you.

Speaker 0

Thank you. Our next question is from Julio Romero of Sidoti. Your line is open.

Speaker 7

Hey, good morning everyone.

Speaker 3

Good morning Julio.

Speaker 7

Just to piggyback on Stephen's question earlier, if that large customer does spin out that cabinet and windows business, how do you guys think about that scenario where the remaining OEMs would potentially get a little more bargaining power? Is there anything that could potentially get in front of that today and potentially offset that? Just how do you guys think about that?

Speaker 3

No. I think based on what we know in conversations with that customer, I think the most likely outcome is business as usual.

Speaker 7

Okay. That's helpful. You mentioned in the press release and obviously in the numbers, inventories definitely stepped up in preparation for the spring selling season. Can you just talk about what volumes are expected for cabinet components in the spring? I know that there's been some promotional activity in the home center.

So just trying to think about what to expect for the spring season. Thank you.

Speaker 3

Yes. So far, I mean, the early indications are after what was a pretty tough first quarter, not just for us. I mean, you look at the industry statistics for cabinets in that semi custom space, they were down as opposed to any kind of growth. I think the expectation right now, both for us and for the industry, is low single digit growth as we progress through the spring and summer here.

Speaker 7

Okay. That's helpful. Thanks very much. I'll hop back in queue.

Speaker 0

Thank you. And that concludes our Q and A session for today. I'd like to turn the call back over to Mr. Bill Griffiths for any further remarks.

Speaker 3

Thanks, everyone. I appreciate you joining the call, and we look forward to updating you next quarter and we'll be seeing some of you shortly at various conferences and road shows. Thank you.

Speaker 0

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program and you may all disconnect. Everyone have a great day.